Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

What Investors Got Wrong About the eBay/PayPal Announcement

While both companies are complying with the terms of the divorce, the details are important, and investors on both sides are overreacting.

When PayPal Holdings, Inc.(NASDAQ:PYPL) reported its fourth-quarter and 2017 full-year earnings after the market closed on Wednesday, investors got what they have come to expect from the digital payments processor: impressive year-over-year growth in both revenue and earnings.

What they didn't expect, though, was the announcement that eBay(NASDAQ:EBAY) will begin to process its own payments, with the help of privately held PayPal competitor Adyen. Many had expected a renewal of the operating agreement that was forged when the two companies separated.

The news sent PayPal's stock reeling, falling as much as 10% following the announcement, while eBay's stock jumped as much as 15%. As in any divorce, the two companies are telling slightly different versions of the story, with the reality falling somewhere in between.

From eBay's perspective

eBay revealed during its conference call that it had made the decision to "intermediate payments" and that it would be gearing up as quickly as it was allowed under the terms of its operating agreement with PayPal. eBay said it had reached a deal with privately held global payment processor Adyen to be its partner in the endeavor, and that by 2021 it expects that the majority of its customers will be using its new payment platform.

The motive for this move was, of course, money. eBay believes it will be able to capture significantly better economics while reducing overall selling costs. It's also hoping to provide sellers more choices, but eBay will become the payment processor of record and earn the fees it previously relegated to PayPal. eBay also expects to pass some of the savings along to its sellers and expects that the associated fees will add incremental revenue of more than $2 billion annually.

What PayPal said

PayPal indicated that payments from eBay's marketplace represented only 13% of payment volume in the fourth quarter, down from 16% in the prior-year quarter, and about 22% when the two companies separated. PayPal expects that by the time the operating agreement expires in 2020, eBay will generate only about 4% of PayPal's payment volume.

While PayPal's business has been experiencing significant growth, the eBay portion of that business has been growing much more slowly, according to PayPal. During the 10 quarters since parting ways, the eBay portion of PayPal's revenue has grown by an average of only 4%, while the remainder of PayPal's revenue has increased by 23%.

PayPal was also quick to point out that under the terms of the operating agreement, it is prohibited from being the merchant of record for a number of specific eBay competitors, including some of the largest and fastest-growing online marketplaces worldwide. PayPal is in discussions with some of those names now, but it won't be able to partner with them until the operating agreement expires.

What they agree on

There are a few things that both eBay and PayPal agreed upon. The operating agreement the companies signed is still in effect and won't expire until July 2020.

The agreement stipulates that eBay may begin testing new payment processors beginning in 2018, accounting for up to 5% of its payment volume in two countries of its choice. The amount of payment volume it is permitted to migrate increases to 10% in 2019, and the operating agreement expires in July 2020, when PayPal is likely to relinquish the remaining payment processing duties for eBay. It will, however, still be a payment option for customers.

In a blog post on its website, eBay acknowledged the limitations:

eBay will begin payments intermediation on a small scale in North America starting in the second half of 2018, expanding in 2019 under the terms of the Operating Agreement with PayPal. In 2021, we expect to have transitioned a majority of marketplace customers to the new payments experience.

Not much is changing

While investors on both sides appear to have had a knee-jerk reaction to the announcement, nothing much has changed. For now, PayPal will be losing about 5% of its payment volume from two countries. For its part, eBay will retain the fees from those same payments it would otherwise have paid to PayPal. The terms of the agreement have been in place since the companies went their separate ways.

Move it along, folks. There's nothing to see here.

Danny Vena owns shares of PayPal Holdings and has the following options: long January 2019 $18 calls on eBay and short April 2018 $35 calls on eBay. The Motley Fool owns shares of and recommends eBay and PayPal Holdings. The Motley Fool has a disclosure policy.

Author

Daniel W. Vena, CPA, CGMA is long-term investor searching for intangibles that provide explosive growth opportunities in his investments. He served on active duty with the US Army and has a Bachelors degree in accounting.
Follow @dannyvena